Lessons and Ideas from Benjamin Graham Jason Zweig Investing Columnist Money Magazine New York City Benjamin Graham wrote his first book on investing in 1934, and although he refined these thoughts over time, his message (and the truth therein) has remained the same. Thus, Graham was not a man ahead of his time; he was a man for all time. n June 2003, HarperCollins Publishers asked if I retail investors and investment professionals. For I would be interested in updating Benjamin Gra- example, many of the businesses that Graham dis- ham’s classic The Intelligent Investor.1 After determin- cussed in the last edition of the text had to be placed ing that the proposal was not somebody’s idea of a in their historical context, and some required more practical joke, I agreed to take on the project. And as explanation than others. For instance, most invest- I worked on revising the book, I was reminded, once ment professionals know that Studebaker was once again, what a genius Graham was. So, in the course a stock, but far fewer of them know much about the of this presentation, I will discuss the following: Northern Pipeline Company or the other companies • the things that made him famous, that are integral to Graham’s discussions. • the factors that caused his reputation to drop out The other part of my job was to write commen- of fashion, taries to accompany all of Graham’s chapters. Each • the insights that make him relevant today, and of my commentaries explains the basic principle that • the many ways in which he showed himself to Graham addressed in the chapter, describes what be a man of brilliance. has happened in recent years to the investors who did—and did not—listen to him, and suggests how Becoming Reacquainted with Graham’s principles might apply in the future. As I worked on the project, one of the questions Graham I kept asking myself was: Is Graham still relevant? My work on Graham’s book took about five months. After all, this was a man who was born in 1894, Before that, however, I spent several months throw- began working on Wall Street in 1914, wrote Security ing ideas back and forth with the HarperCollins edi- Analysis in 1934,2 and wrote the first edition of The tors to settle on an appropriate way to approach the Intelligent Investor in 1949, primarily using ideas that project. What we decided on was this: I could not were fully formed in his mind by the early 1930s. A change the original text. After all, you do not rewrite lot has changed since then, and Graham came under the Bible. So, if I was not going to change the original a great deal of criticism in the late 1990s. For exam- text, we had to come up with something for me to do. ple, consider the following remark from Jim Cramer: As it turned out, my role was twofold. “You have to throw out all of the matrices and One part of my job was to annotate the existing formulas and texts that existed before the Web. text (the 1972 edition, which was Graham’s fourth If we used any of what Graham or Dodd teach us, revision)—the purpose being to make the book more we wouldn’t have a dime under management.”3 comprehensible for contemporary readers, both But Graham anticipated comments such as this one. Graham knew that people were going to say 1Benjamin Graham, The Intelligent Investor, rev. ed., updated with such things about him someday, just as he seemed to new commentary by Jason Zweig (New York: HarperBusiness, 2003). The first edition was published in 1949 by Harper, and a 2Benjamin Graham and David L. Dodd, Security Analysis (New fourth revised edition was published in 1972 by Harper & Row. I York: Whittlesey House, McGraw Hill Book Company, 1934). will refer to these three editions throughout my presentation. 3James J. Cramer, thestreet.com (29 February 2000). ©2004, AIMR® www.aimrpubs.org • 9 Equity Analysis Issues, Lessons, and Techniques know so many things before they happened. In fact, famous is that when the price of a stock is less than the 5 May 1974 edition of the New York Times quoted 1.3 times the tangible book value, it should be a good him as saying: “[My books] have probably been read value for the investor. and disregarded by more people than any book on Graham is also well known for his idea of “net finance that I know of.” Much as Mark Twain said nets,” which means, in essence, that if investors can about the weather, Graham understood that people buy stocks for less than the value of net working would read the ideas in his books but that nobody capital, they will always do well. And historical would do anything about them. So, I struggled with evidence has shown this axiom to be true. Unfortu- this issue: How relevant is Graham’s book today? nately, history also shows that the market provides I had read the book twice myself. It was the first such opportunities, on average, perhaps once every book I read when I became a financial journalist in 27 years. One such opportunity occurred in the early 1987, and I had read it again in the early 1990s. But 1970s and another occurred in the wake of the 1999 when I started this project, I had not read the book stock market bubble, but it appears to be gone from cover to cover in a decade, although I had already. Such windows open quickly and close just always kept it on my shelf and frequently referred to as fast. individual chapters or specific passages. When I read Graham wrote a series of articles in Forbes in it again at the beginning of this project, I could not 1932 in which he talked extensively about the signif- believe how good it was—and how relevant. icance of buying stocks for less than net working capital and why no one was doing so but him. It is Why Graham Fell Out of Fashion in these articles that he coined the phrase “those with and Why He Is Famous the enterprise haven’t the money, and those with the money haven’t the enterprise,”4 which is almost, by Graham is often regarded as a kind of judgmental or definition, why valuation can go so low: The people formulaic market timer, not in the sense that Elliot who could buy are too scared to make a move, and Spitzer has made famous but in the sense that one the ones who know they should buy do not have should get out of stocks when they are overvalued enough capital to do so. and stay in cash or bonds until stocks get cheap again. A lot of the early chapters in Graham’s book are given over to his ruminations on when investors should be Why Graham Should Be Famous in the market and when they should be out. Such I would not presume to tell an audience of CFA emphasis on market timing is largely out of fashion charterholders what Graham’s valuation formulas today. His basic formula is that when investors think would be today. For one thing, they would not be the stocks are cheap, they should have up to 75 percent formulas for which he is well known because, as I will of their assets in stock. When stocks are expensive, show, one of the things that Graham should be famous they should reduce their holdings to as low as 25 for is that he was a great American tinkerer. In the percent and keep the rest in bonds or cash. It is an same tradition as Edison and the Wright Brothers, interesting formula—and not all that different from Graham was constantly experimenting and retesting the kind of tactical asset allocation that many pension his assumptions and seeking out what works—not funds currently use. what worked yesterday but what works today. In Graham is probably most famous for the various each revised edition of The Intelligent Investor, Gra- valuation metrics that he spelled out in Security ham discarded the formulas he presented in the pre- Analysis and The Intelligent Investor. Graham would vious edition and replaced them with new ones, roll over in his grave if he heard me use the word declaring, in a sense, that “those do not work any “metrics” in the sense that was made popular in the more, or they do not work as well as they used to; late 1990s, but it is good shorthand and, as rules of these are the formulas that seem to work better now.” thumb, the formulas are familiar to many of us. For One of the common criticisms made of Graham example, on the one hand, Graham said that investors is that all the formulas in the 1972 edition are anti- should stay away from growth stocks when their quated. The only proper response to this criticism is normalized P/Es go above 25. On the other hand, to say: “Of course they are! They are the ones he used when the product of a stock’s normalized P/E and its to replace the formulas in the 1965 edition, which price-to-book ratio (price/book) is less than 22.5— replaced the formulas in the 1954 edition, which, in Normalized P/E × (price/book) < 22.5—it is at least turn, replaced the ones from the 1949 edition, which a good value.